S&P finally says subprime is mostly junk

Standard & Poor's just drove a huge harpoon into the heart of the mortgage credit bubble, and it's going to take a long time to clean up the mess once the beast finally dies. S&P, one of the three main credit-rating agencies that served as enablers of the subprime-mortgage boom, announced Tuesday [10 Jul 2007] that it would lower its ratings on 612 bonds, a small portion of the mortgage-backed securities it had given its seal of approval to. See full story.

S&P said it would change its methodology for rating hundreds of billions of dollars in residential-mortgage-backed securities. And it would review its ratings on hundreds of billions of dollars in the more complex collateralized debt obligations based on those subprime loans. A lot of debt will be downgraded to junk status. A lot of pension funds and hedge funds that once thrived on the high returns they could get from investing in subprime junk will now lose a lot of money.

theoildrum.com -> bloomberg.com :

Prices of some bonds backed by subprime mortgages have declined by more than 50 cents on the dollar in the past few months while their credit ratings haven't changed. A downgrade would be S&P's biggest reduction of subprime ratings. Insurers and pension funds may be among investors required to sell their bonds if they are downgraded, potentially driving down prices of $800 billion in subprime mortgages and $1 trillion of collateralized debt obligations, which package mortgage bonds into new securities. S&P said it is also reviewing the "global universe" of CDOs that contain subprime mortgages. Investors in CDOs alone stand to lose as much as $250 billion, according to Institutional Risk Analytics.

Gresham's Law and the Indian coin shortage

theoildrum.com -> dailyreckoning.com.au :

Gresham's Law is popularly known as, "Bad money drives out good money". In effect, people will hoard valuable money but will spend (and thus get rid of) money that is relatively more worthless. The case in point that JMR Ben thoughtfully provided was a link to the news.bbc.co.uk report titled "Sharp Practice of Melting Coins". It seems that inflation in prices in India (due to the Indian central bank creating so damned much money and credit every freaking day, just like all the other stupid central banks of the stupid world) has made the rupee almost valueless, but the little bit of metal in the coins is so valuable that "Millions of Indian coins are being smuggled into neighbouring Bangladesh and turned into razor blades".

How much more valuable is the metal in the coin? The conversion ratio is a one-rupee coin can be made into seven razor blades, worth 35 rupees! The natural result of Gresham's law in action is "an acute shortage of coins in many parts of India". The most surprising, astonishing and terrifying thing was the actual, in-your-face admission of further government debasement of the money! My eyes pop from my head in disbelief as I read that "The mints took corrective action - scaling down the metal content of the coins - but that has not stopped the shortages".

If the Indian mints wanted to take "corrective action" against the inflation that is rendering the coins worthless as money, they would storm the central bank of India and stop them from creating so much money and credit! And it is not just Indians, but according to a fax of a Globe and Mail article from Junior Mogambo Ranger (JMR) Andrew G., inflation in Canada is making them think of ditching the penny. The metal in the Canadian penny is worth so much more than the one-cent face value of the coin that pennies are, just like in India, being hoarded.

This phenomenon of disappearing coins must be happening almost everywhere, too, as all currencies are being debased by their central banks, and coins with a low, fixed denomination on them are doomed as the buying power of the coin falls below the melt value of the metal in the coins. And sure enough, the article notes that "Australia [stopped] making one-and two-cent coins in 1990. New Zealand stopped making them three years before that. France, Norway and Britain are among the other countries that have eliminated low-denomination coins." So inflation is hitting everywhere, literally rendering money increasingly valueless, and yet the governments allow the banks to just keep printing more and more of it! This is insane!

- They have stopped making the Singapore 1-cent coin years ago too. The official reason is that "the 1-cent coin is not actively used by the public". But why are the 1-cent coins not actively used by the public? Because they are effectively worthless. Why are they effectively worthless? Because of the relentless growth in money supply, which leads to monetary inflation, which makes every dollar yesterday worth less than a dollar today, and every cent yesterday worth less than a cent today.

At least, 5 years ago, gov.sg took action long before the people themselves did. You know, hoarding the coins to melt them down for their scrap value, for a tidy profit, like the Indians seem to be doing nowadays. That would have been quite embarrassing, wouldn't it?

In true geek style, I have done the following calculations :

1. Metal content and weight of Singapore 1-cent coin : 1.24g copper-plated zinc (singaporemint.com)
2. Ratio of zinc to copper content : zinc 97.5%, copper 2.5% (cmd-chart.blogspot.com) (assuming we use a similar ratio)
3. Price of zinc as of 24 Jul 2007 : US$3820 per metric ton (metalprices.com)
4. Price of copper as of 24 Jul 2007 : US$8160 per metric ton (metalprices.com)
5. USD to SGD spot exchange rate : 1.5076 (my.yahoo.com) (my customized page)
6. Value of metal content in 1-cent coin : (3820x0.975 + 8160x0.025) / 1000 / 1000 x 1.24 x 1.5076 x 100 = 0.734 cents

Well, as you can see, we're not yet at parity but it's probably a matter of time and inflation. Now that you have the formula you can re-calculate it any time you like.

Welcome to Drop World

Dow Jones drops 200 points, Canadian TSX drops 400 points (!),
S&P500 drops 50 points, Japan Nikkei drops 211 points,
New York NYMEX crude oil drops $2, gold drops $6.

- Welcome to Drop World.

When Biow said she wanted to sign up for a DBS Vickers Online account, just like mine, and wanted to get into the stock market, and wanted to make her money "grow fast", alarm bells went off in my head. I told her once she goes into the market, it will crash. That she is the ultimate contra market indicator. That her entry into the market will cause the entire global stock and asset markets to simultaneously crash, single-handedly wiping out trillions of dollars in equity.

Ok, so maybe I exaggerate. A little.

Well, guess what. Biow managed to buy her first shares sometime yesterday night (mid-afternoon, actually, New York time). Today, she told me that her buy order got filled. She said to me, "beware and be warned!"

I could draw parallels to what is happening in China, and to what happened just prior to the start of the (First) Great Depression, with the October 1929 stock market crash. When newbies start signing up for bokerage accounts and enter the markets in droves, that is when contrarians start to get worried. And I count myself a friend and member of the contrarian community.

Be afraid. Be very afraid. :)